4/02/2001 @ 12:00AM

Aiding and Abetting

All those tech companies that are padding their revenues couldn’t be doing it without some conniving by their customers. Such is the reasoning of the
Securities & Exchange Commission
. In a new line of attack, the agency’s Silicon Valley bureau is pursuing not just the padders but the accomplices. Brace yourself for some nasty enforcement actions.

“All too often, companies wouldn’t be able to accomplish the frauds without the assistance of their customers. We want to make customers stop and think before they play these games that they may get hit with a lawsuit from the SEC,” says
Helane L. Morrison
Helane L.
Morrison
, district administrator of the SEC’s San Francisco office, which oversees Silicon Valley. The U.S. attorney’s office in San Francisco, which works with the SEC on accounting fraud cases, is also gearing up its surveillance.

A telling example of customer collusion is the imbroglio surrounding
McKesson HBOC
, the San Francisco health care products distributor. In January 1999 McKesson bought HBO & Co., a health care software vendor, for $14 billion. McKesson overpaid. It was soon revealed that HBOC had used sham deals to inflate profits big-time. In July 1999 McKesson HBOC restated three years of earnings. The stock promptly skidded from $65 to $34, where it remains today. The alleged overseers of the fraud, HBOC’s former co-presidents, Jay Gilbertson, 40, and Albert Bergonzi, 51, are now under criminal indictment and face up to ten years in prison plus a $1 million fine each. Both have pleaded not guilty. McKesson HBOC says it took immediate and sweeping measures to fix the mess.

Backdating at McKesson HBOC was clearly out of control, involving hundreds of sales contracts, according to investigators. For instance, on Apr. 5, 1999, almost a week after McKesson HBOC closed its 1999 fiscal fourth quarter, computer hardware maker Data General suddenly agreed to buy $20 million of HBOC software in a deal backdated to Mar. 31, 1999. The deal, which made up 17% of its software revenues for the fourth quarter, helped McKesson HBOC beat analyst forecasts, with 62 cents a share in quarterly earnings. Without the deal, it would have missed the estimates.

But what did Data General get? A simultaneous contract to sell $25 million of hardware to McKesson HBOC, plus a side letter that said it could return the software. Michael Dicke, an SEC enforcement official in San Francisco, terms the deal “very unusual” because Data General, as a hardware manufacturer, has little need for software. Computer storage giant EMC, which bought Data General last fall, declined comment.

HBOC also got Internet health company WebMD to backdate to Dec. 31, 1998 a $5 million software sales contract that was actually inked Jan. 7, 1999. And who negotiated the backdated contract on WebMD’s behalf? HBOC’s Gilbertson, who by then had quit HBOC to become WebMD’s president and chief operating officer. WebMD says he has left the company, declining further comment; Gilbertson’s attorney says he denies the charges. Bergonzi also declined comment. To date the SEC has not filed any action against Data General or WebMD in the matter. It declined further comment.

But in a case involving
Hybrid Networks
, a wireless communications outfit in San Jose, Calif., the SEC did admonish an executive at its distributor, Ikon Office Solutions, to watch his step. When Hybrid felt its weak fourth-quarter-1997 numbers wouldn’t support the valuation of its recent initial public offering, it sent out an SOS to Ikon, asking the distributor to buy $1.5 million worth of modems. “It’s very common for a manufacturer to call you up and say, ‘I need to hit my quarterly number, would you mind giving me a purchase order for $100,000?’” Ronald Davies, the Ikon executive who handled the sale, told FORBES.

Davies, a churchgoing Mormon, says he first balked because Ikon didn’t have any customers for Hybrid’s modems. Still, maintaining a good relationship with the supplier won out, and Ikon placed the order on the last day of Hybrid’s fourth quarter. To make this easier to swallow, Ikon got a side letter that essentially said it could return the modems without paying for them. And that’s exactly what Ikon did, in 1998.

But when the SEC saw that a third of Hybrid’s fourth-quarter revenue came from one not-so-final sale made on the last day of the quarter to one customer, it sued Hybrid. After Hybrid restated its 1997 earnings, its losses deepened to $22 million. Davies got hit with a cease-and-desist order telling him not to violate securities laws again. He had e-mailed Hybrid claiming no knowledge of secret side letters, which Hybrid then gave to its auditors.

Sometimes it takes more than side letters to seduce customers. For Troy Lee Wood, 48, it took $17,000 in cash and gifts. That’s what the former president of Dallas-based
National Health Services
got in return for signing off on a bogus $1.3 million purchase of software and equipment from Automated Telephone Management Systems. And ATM, which needed the deal to meet its 1993 numbers, told Wood that National Health would not have to accept the products or pay for them. The SEC says Wood then supplied three fake documents that ATM used to substantiate the sale to outside auditors.

Wood played down his role in an interview and says that the $17,000 in gifts were “referral fees” for directing other customers to ATM. “I didn’t even know I was doing something wrong,” he says in an interview. After the SEC slapped him with a cease-and-desist-order, Wood became a self-employed insurance salesman. ATM shut down in 1994.

Leslie R. Caldwell, assistant U.S. attorney in San Francisco, figures there will be a lot more customer mischief to sniff out over the next year. “As there’s an economic downturn, it will become more tempting [to fudge sales],” she says. Investors didn’t need another reason to be leery of high-priced tech stocks, but they’ve got one here.